In late October, we presented a petition to parliament seeking an inquiry into direct monetary financing for infrastructure. We have followed it up with a supporting submission.
Following is an extract from our submission. You can read the full submission here (PDF).
What this petition is about
On 14 May 2020, as the first shockwave of Covid hit New Zealand, officials from the Treasury and Reserve Bank delivered a paper to the finance minister. It compared two methods the government could use to finance its crisis response. One was quantitative easing (QE), called Large Scale Asset Purchases (LSAP) by the Reserve Bank. The other was monetary financing, also known as direct monetary financing (DMF), the subject of this petition.
In both cases, the Reserve Bank provides financing to support the government. But QE works through the financial markets (by using the new money to buy back bonds from financial institutions), while direct monetary financing bypasses them (by spending the new money directly into the economy). Both options have strengths and weaknesses as the officials’ paper outlines.
QE was the method chosen in this particular instance and, as we saw, it had both strengths—it helped to stabilise jittery financial markets and supported government borrowing—and weaknesses—it helped drive a massive housing bubble and cost more than $11B in financial losses to the government. It’s likely that direct monetary financing would have avoided or reduced these problems.
Direct monetary financing is not new and has been used before in New Zealand and elsewhere. It is a powerful public financing tool that is sitting idle, ready to use—like much of the human and physical resources that could be put to work with it.
What direct monetary financing can do
As Treasury has confirmed, no new legislation is needed to use direct monetary financing. We could use it today to put people and resources to work building critical infrastructure and filling the productivity-sapping gaps from decades of underinvestment.
New Zealand has a pressing and costly need for public infrastructure after years of underinvestment. The Infrastructure Commission estimated in 2022 that we needed $31B/year to tackle current and future infrastructure challenges. Add interest to that bill and the cost could more than double.
To illustrate this, if the government borrowed at the recent 10-year bond coupon rate of 4.5%, then $31B would become $72B over 30 years. Under direct monetary financing there would be little or no interest charged and that extra $41B could fund public services or the maintenance and operation of those assets.
Our petition asks parliament to consider using direct monetary financing to reduce this interest bill on major infrastructure. In addition, as we show, it can improve infrastructure delivery and grow the economy, and strengthen monetary sovereignty at a time of disruptive global change.
What we are asking parliament to do
In our view, before direct monetary financing can be used responsibly and effectively outside times of crisis, it needs a robust institutional framework. This is the key issue we are asking parliament to consider.
The need is there and a financing tool that can help address it is available, but it is poorly understood. Its advocates often claim too much for it (“We can have anything we want! We can eliminate taxes!”), and its critics are too quick to dismiss it (“Politicians will misuse it! It will turn us into a Zimbabwe or Venezula!”).
We believe it is time to start a wider, more informed and nuanced conversation about how we finance our economy with its considerable investment needs, and the part that direct monetary financing can play. An inquiry by parliament can start and inform this conversation, and now is the time to do it.
The slow-burning crisis of infrastructure underinvestment gives us the opportunity. It has been at times of major investment that it has been used most successfully here and elsewhere.
And if we have any more doubts about timeliness, the upheaval taking place in the global monetary system right now should tip the scales. Technology and geopolitics are fast converging in ways that will impact the sovereignty of currencies like ours. This makes it even more important that we are deeply engaged with the issues and arrangements underpinning our monetary sovereignty.
We are not proposing that direct monetary financing should replace current forms of public financing, such as tax or bonds, only that it should be an important addition to the public financing toolkit.
In this submission, we:
- Show how DMF would work within our monetary and public finance systems
- Offer some high-value use cases and explain its benefits compared to other forms of financing
- Address some of the concerns commonly raised
- Outline institutional guardrails that would allow us to enjoy the benefits while minimising the risks
- Explain why it is timely now to undertake this inquiry.